Clorox (CLX -0.77%) managed to improve its gross margin by 5.6 percentage points year over year in the fourth quarter of fiscal 2023. That’s a huge improvement that was helped along by a drop in the rate of cost increases that the company faced due to inflation.
But inflation has not gone away. In fact, management made sure to highlight two important trends on this front when it spoke to analysts. Investors need to understand exactly what is going on with inflation and what it means for Clorox’s business from here.
Inflation is always present
Inflation waxes and wanes, but it generally doesn’t go away. There are sometimes periods of deflation, but they have usually been pretty brief. So rising costs are pretty much a constant that businesses have to navigate. Consumer staples companies like Clorox have a well-worn playbook on this front.
The first move is usually to cut costs. Sometimes that’s as simple as switching to ingredients that are less expensive; at other times, a company may resort to things as extreme as closing operations and terminating employees.
The second big move is to raise prices. This usually comes in two broad forms — either adjusting product sizes (selling less for the same price) or outright price increases. The problem with this approach is that consumers don’t like to pay higher prices, and some will shift to alternative products. But while these efforts are playing out, a company has little option but to absorb the higher costs and suffer through a period of margin contraction.
Although there were a lot of moving parts with Clorox, the stock plunged when it announced that it had suffered a huge 12.4 percentage point decline in its gross margin in the second quarter of its fiscal 2022. Inflation was a specific headwind the company mentioned as costs were ticking up following the upheaval caused by the coronavirus pandemic.
Costs are rising at a slower pace
To put some numbers on what has been going on, management highlighted during its fourth-quarter 2023 earnings conference call that it faced around $800 million in additional costs in fiscal 2022. It described that as extreme. The figure for fiscal 2023 was roughly half of that, at roughly $400 million.
That’s a huge difference, with cost inflation running at half the rate of the previous year. That was a big help on the gross margin front which, as noted above, improved 5.6 percentage points year over year in the fourth quarter of fiscal 2023. For the full fiscal year, the improvement was 3.6 percentage points. But a drop from $800 million to $400 million is not the same as inflation going away. It is simply the pace of the increase slowing.
In fiscal 2024, meanwhile, Clorox is expecting inflation to be a headwind of roughly $200 million. Again, that’s half of what it was in fiscal 2023, so the impact is getting less and less onerous. But inflation isn’t going away. The biggest contributors in fiscal 2024 are expected to be commodities (about a third of the total) and manufacturing and warehousing (the rest), where the primary contributor is labor costs. In other words, salary expenses are still heading higher.
So the first important fact that investors need to understand here is that the inflation headwind Clorox is facing is softening, but it isn’t gone. The next piece of information that needs to be understood is that, according to CEO Linda Rendle, the $200 million inflation impact that’s being projected for fiscal 2024 is still three times the level of inflation the company faced prior to the pandemic-related spike.
That puts the scale of the $800 million headwind from fiscal 2022 into much clearer relief, and highlights the fact that inflation may be slowing down, but it remains a massive issue. Don’t let the declining impact fool you.
Clorox still has a lot of heavy lifting to do
As fiscal 2024 gets underway for Clorox, the impact from inflation has lessened but is far from over. Management is confident it can cut costs enough to offset most of the impact of that $200 million headwind, which is good and will reduce the need for more price increases.
But investors shouldn’t think that less of an inflation impact means the company can stop working as hard to protect its margins. In fact, three years into this inflation surge, cutting even more costs out of the production process will likely be harder since the low-hanging fruit is long gone at this point.
Clorox’s turnaround has been moving in the right direction. But despite this fact, investors still need to keep a vigilant eye on costs and the gross margin to make sure that trend continues.